Your questions answered
Our FAQs page seeks to address the fundamental issues of franchising for the beginner. We hope to broaden its scope and would welcome further questions from visitors to our site on issues they have found puzzling. Click here to contact us and pose your question.
The other big advantage to the franchisor is that it can expect that, as you have invested your own money, you will be more motivated and committed over the long term to make the business successful than an employee.
You pay an initial fee to cover your training, and the rights to use the brand and the business system for the period of the franchise contract.
Also you will pay regular ongoing fees, a fixed fee, or based on a percentage of your turnover, or a mark-up on the goods that you are obliged to buy from your franchisor. There may also be an advertising/marketing levy, again based on a fixed fee or turnover.
The latter is critical. Franchising is not about investing money, sitting back and spending the profits. Launching and developing a new business, even with the back-up of a competent franchisor, is hard work. Franchisors are seldom looking for what are known as absentee investors. They need hard-working, fully committed franchisees.
The question can best be answered by looking at the franchisor’s projections for the business and asking current franchisees whether they found them to be realistic.
If the figures are impressive and you are prepared to work equally as hard as the franchisees you have met, you should be able to look forward to similar profits. After all, you will have had the same training and help that they did so on that basis, given your location offers similar potential to theirs, whether you succeed or not at the end of the day is down to you.
Would it be better for me to go it alone in a conventional business and not have regular fees to pay?
You would also face much less risk than you would if you were starting out on your own, particularly in a type of business in which you had no knowledge or experience.
With a franchise you have all the help you need to set up your own branch of a business in which success has been demonstrated by its existing franchisees.
Speak to them, and ask their opinion of aspects such as the standard of their initial training, the accuracy of the franchisor’s financial forecasts (income, outgoings, etc.) and the level of ongoing support they receive.
What can you afford? What are your personal aptitudes and working background? What would you really like to do for the rest of your career? Would the business need the support and participation of your family? Would the franchise be profitable enough to support your lifestyle? Would it meet your work/lifestyle balance aspirations?
Before looking at these questions in-depth, you need to ask yourself whether you are, in fact, suited for self-employment, and whether you would be prepared to run the business according to the franchisor’s rules. You will at the end of the day own your own business, but you must accept the fact that you are not entirely your own boss as you must run it according to the franchisor’s system.
This is necessary to maintain the quality and integrity of the whole network. After all, you are buying into the system not just to benefit from the brand but also its proven business system so why try to change it?
The franchisor category itself has three classes to reflect the different stages of their development. Full members are those who have been established the longest and reached the stage at which their network is financially self-sustainable without the necessity to recruit further franchisees. They are each subject to re-accreditation from time to time.
The next franchisor class is for associate members, who are younger systems working towards recognition as full members. The third franchisor class is for listed provisionals whose systems have been running for at least a year and are being guided by BFA-accredited advisers.
All three franchisor classes must adhere to the association’s regulations and most importantly, its code of ethical practice, particularly in the terms in their franchise contracts.
The second category is for franchisees in the networks of all three categories of franchisor members.
The third category is for affiliates, who are service providers, such as franchise consultants, lawyers, bankers and accountants.
The three categories are represented on the BFA board of 20 directors, which include the director-general. The full member category has 11 members, associates 2, affiliates 3 (including one legal) and franchisees 3.
There are implications for prospective franchisees in the three classes in the franchisor category. The longevity of full members indicate that they offer the safest investment, but are likely to have the narrowest choice of territories. Some may have networks that are sold out and therefore can only offer occasional resales that, as going concerns, are offered at considerably higher prices than start-ups. In the latter case, loans will be easier to obtain because the outlets have established successful trading records.
The position with companies that are listed provisionals is the opposite. As their networks are young, there is likely to be a wide choice of territories on offer, all at start-up prices. The downside is that loans may be harder to obtain as the risk assessment factor can only be supported by projections based on either company-owned pilot units or early franchised units.
Certainly, the franchisee owns his business, but it is only able to trade in a particular franchise under a contract with the franchisor for a stipulated period, usually with the option to renew for a further term.
The length of the period is important because it must be long enough to enable the franchisee to make an ongoing profit, whilst repaying the whole of the money with interest that has been borrowed from the bank to pay the initial franchise fee and setting-up costs. These costs can be considerable in such sectors as fast-food and retailing. If the franchise period is not long enough to repay the debt, the bank to protect its client would be unlikely to make a loan.
It is only by owning the business that the franchisor can be in the position to police the network and ensure that each franchisee maintains the brand’s standards and reputation. As we have seen, the success with which the franchisor exercises its control is crucial over the long term.
This issue was made clear by one of the UK’s earliest and most successful franchisors who preferred to call the system ‘business leasing’, as it is a process in which the franchisee ‘leases’ the franchisor’s brand and business-format for a contracted period.
Might the necessity to strictly follow the franchisor’s formula make the business insufficiently challenging?
However, franchising does offer the ambitious the opportunity to become a multi-unit franchisee with a significant regional chain of outlets.
If you are highly ambitious, negotiate with your prospective franchisor at the buying stage to include in the agreement an option on extra territories/sites. Some franchisors particularly welcome franchisees who have aspirations to open a number of outlets and are particularly looking for candidates with the ambition to become multi-unit franchisees.
The benefits for the franchisor is that it doesn’t have to face the costs of recruiting and training the ambitious franchisee and, most importantly, knows that he is successful in the business. You suit them, and they suit you. Also financing extra units is easier as it can come from the profits of the earlier branches.
True entrepreneurs are, however, unlikely to be fulfilled in conforming to what they increasingly see as restraints imposed by the franchisor and they may, in fact, be better suited to starting a conventional business from scratch and go on to develop it as a franchise system.
This causes two problems for the franchisor. Firstly, it puts a cap on the future royalties it receives from taking a percentage of the franchisee’s turnover. Secondly, it gives competitors the opportunity to capture a greater share of the market.
This situation is not easy for the franchisor to overcome. It can offer incentives, such as a reducing sliding scale of royalties for higher turnovers and persuading the franchisee to sell back part of his area to create an extra territory for a new franchisee. Ultimately, however, the franchisor may have to try and entice the franchisee to sell by offering to buy him out at an inflated price.
In return, they pay a percentage of their income from initial and ongoing service fees from their franchisees to the parent franchisor. The latter usually imposes a development target on the number of franchisees recruited over specific periods to ensure the holder develops the system.
Franchisors sell such franchises, rather than franchising directly, to avoid the cost and risk of piloting and developing their system in a country in which they have no experience of the market or culture.
They usually hedge their bet by including in the agreement a buy-back option that they can exercise after a period of time if the franchise proves successful.
It is not unknown for a wealthy U.S. franchisee to take a master franchise for a foreign country in the system in which he has made his wealth. This is an example of the more unusual entrepreneurial opportunities within franchising.
The relatively few cases that have reached the courts have usually been brought by franchisees for misrepresentation. Has the franchisor misrepresented the profits the franchisee could expect? Has the forecast for the sales figures been exaggerated or the setting up costs reduced?
Whether the franchisor has answered these questions accurately can usually be found by interviewing existing franchisees. Care must, however, be taken to ensure that the franchisee hasn’t been primed. That can best be avoided by having the freedom to approach all franchisees.
Franchising has, however, a favourable reputation largely due to the work of its self-regulatory trade association, the BFA in creating and enforcing its code of ethics. Membership is voluntary but even non-members are aware that in order to recruit successfully they must undertake to adhere to the association’s regulatory measures.
The banks have also contributed by establishing franchise departments with a thorough knowledge of the system and franchisors. They often have financial insight into particular franchise systems as their franchisees are clients of the bank.
The EU initially became legally involved because the agreement between a franchisor and its franchisees is a restrictive contract (territorial rights, purchasing restrictions, etc.) and thus conflicts with its competition law.
This problem was recognised, when a case, brought by a franchisee, raised the legality of the franchise agreement in the EU, came before the European Court of Justice in 1986.
This led to the EU granting franchising exemption from certain clauses in its competition law that would have made the system unworkable in Europe. This is now enshrined within the EC Block Exemption Regulation on Vertical Restraints.
If franchisees were allowed to make their own changes, standards would differ from outlet to outlet; the franchisor would lose control; and customers would not get the same service across the network.
As a result, the quality of the franchise and its brand would decline, and along with them the resale value of your business, when it comes to the stage you want to sell and make a substantial capital gain.
The franchisor’s refusal to make changes is an indication of the strength of its system. Conversely, if it allows changes to its formula it is a sign of weakness and often its desperation to recruit franchisees. One of the most essential jobs of the franchisor is to police its network effectively.
As the franchisor has to protect its interests and those of the network even beyond the point at which you may have left the franchise, the contract can still control the options available to you after the two of you have parted. A franchisee can’t take the sign down and continue trading as before but under a different name.
After all, it provided your training and its business system. It wouldn’t like you to become a competitor and will want to resell your territory to a new franchisee.
Why are there covenants in franchise agreements that restrict the activities of franchisees after they have left the franchise?
The covenants prevent the ex-franchisee for a specified period, usually 12 months, from copying the franchisor’s system to start up a similar business and from soliciting his former clients.
The covenants must not infringe the anti-competition laws of the EU and the UK. Covenants, which are essential for the franchisor to control its franchisees, are by nature anti-competitive and in the past threatened to make franchising unworkable within the legal regimes of the EU and UK. This was, however, overcome by giving franchising exemption from aspects of competition law so long as it confirmed to particular clauses.
It is important for prospective franchisees to seek advice from an experienced franchise solicitor on these covenants so that they are fully aware of the restrictions that will face them when they subsequently decide to leave the franchise.